The bankruptcy laws that have to do with limited liability companies are not clear.
The US Bankruptcy code consists of no explicit provisions for Limited liability companies.
For this reason, bankruptcy courts often refer to state laws to determine what to do when a company like that files for protection.
But, in the 1980s, some trends have started developing since states began categorizing LLCs as legal bodies even though there are few fast and hard rules.
Depending on if an LLC has numerous members or one member, a bankruptcy court can decide to treat it as either a corporation or partnership. Trustees usually categorize LLCs with one- member as partnerships and chase liquidation.
Assets will be sent to the creditors of the company. LLCs with multiple members do much better. This is because they are treated by the court as corporations.
The members stand in line to get a part of the organization’s assets after liquidation. Bankruptcy does not erase or discharge the debts of an LLC. The debtor or the LLC stops existing, but the debts do not.
Under a Chapter 13 plan, an LLC is not allowed to keep running and reorganize. Its only choice is to file for a Chapter 7.
Larger organizations can utilize Chapter 11.
Learn more about different chapters of bankruptcy here.
When an LLC with multi members files for a chapter 7 petition, processing cannot go on except all members are in support of the bankruptcy.
There may be an exception when one or two members oversee the company management exclusively according to explicit language in its agreement.
Impact on Members
Although numerous LLCs members could be treated as shareholders and get a part of the bankrupt organization’s assets, this would not be true if any of them personally guaranteed the debts of the company.
The creditors of the company or a trustee may then depend on them to pay off debts even after the LLC stops existing.
The members or member of the smallest and single member LLCs guarantee the debs of the organization and are liable for them.
Personal Bankruptcy of Members
In a situation where a member has guaranteed the debts and loans of the company, he/she has the choice of filing for personal bankruptcy protection as opposed to company bankruptcy.
He/she will then be able to discharge the debts. In a situation where a member hasn’t made any guarantees, if he gets into problems with his finances and files for personal protection, the Limited Liability Company is generally not susceptible to liquidation to fulfill his personal debt.
Each of the members would need to agree to send the interest of the bankrupt member to a creditor which is unlikely to occur.
In some situations, the creditor may get the distribution payments of members as repayment for his debts.
When the only member of his LLC is a personal debtor, the courts for the bankruptcy in some states see the LLC as assets of the debtors susceptible to liquidation to please creditors.
How Does LLC Bankruptcy Work?
In a Chapter 7 bankruptcy, the assets of the limited liability company are sold and utilized in repaying their creditors.
After the bankruptcy, the remaining debts of the LLC is cleared, and the LLC ceases to be in business. Generally, the owners of the LLCs do not have the responsibility of paying the debts of the LLCs.
However, there are times when the owner of an LLC signed a personal guarantee which makes him liable for the debt of a business.
Landlords, banks, alongside other creditors commonly need personal guarantees when a company is just starting up and has few assets.
To relieve themselves of the responsibility of the debts of their business, owners of LLCs who signed personal guarantees may be required to file a personal guarantee.
At times, the best way of sorting out the financial woes of an LLC is a business bankruptcy.
If the LLC has no assets and the founder has signed a personal guarantee, it may be best to go with personal bankruptcy. Other times, it is crucial to file both.
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